Moody's: Italy's Aa2 Ratings On Review For Possible Downgrade (10-year Bond Yields 4.81%)

Italy 10-Year Government Bond Yield
(Source: Bloomberg.com)
From Moody's Investors Service on Friday June 17, 2011. To your right is Italy's 10-year government bond yield.
"Moody's places Italy's Aa2 ratings on review for possible downgrade

Frankfurt am Main, June 17, 2011 -- Moody's Investors Service has today placed Italy's Aa2 local and foreign currency government bond ratings on review for possible downgrade, while affirming its short-term ratings at Prime-1.

The main drivers that prompted the rating review are:

(1) Economic growth challenges due to macroeconomic structural weaknesses and a likely rise in interest rates over time;

(2) Implementation risks surrounding the fiscal consolidation plans that are required to reduce Italy's stock of debt and keep it at affordable levels; and

(3) Risks posed by changing funding conditions for European sovereigns with high levels of debt.

Moody's review will evaluate the weight of these growing risks in light of the country's high rating but also relative to some credit-strengthening trends that have been observed in recent years and are expected over the coming years, such as improved fiscal governance, lower budget deficits and a modest economic recovery.

RATIONALE FOR REVIEW

First, the Italian economy faces growth challenges in an environment characterized by long-term structural impediments to growth and potentially rising interest rates. Structural economic weaknesses -- mainly low productivity and important labour and product market rigidities -- have been a major impediment to growth in the last decade and continue to hinder the economy's recovery from the severe recession it experienced in 2009. Italy has so far only recovered a fraction of the nearly seven percentage points in GDP that it lost during the global crisis, despite low interest rates, which are likely to rise in the medium term. Growth prospects for the Italian economy in the coming years will be a crucial factor that will determine the government's revenues and the achievement of fiscal consolidation targets.

Second, there are implementation risks to the fiscal consolidation plans that are required to reduce Italy's stock of public debt to more affordable levels. Against a backdrop of rising interest rates and weak economic growth, the government may find it difficult to generate the primary surpluses that are needed to place the public debt-to-GDP ratio and the interest burden on a solid downward trend. The adoption of additional conservative fiscal policies may prove more difficult in the near future because the current government's electoral support is weakening, with the government facing challenges in gaining public approval for its policies. For example, the government's recent energy and water supply proposals were rejected by popular vote.

Third, the fragile market sentiment that continues to surround European sovereigns with high levels of debt poses additional risks for Italy. The continued stability of market demand for Italy's debt is uncertain at current yields. Although future policy actions within the euro area could reduce investors' concerns and stabilize funding costs, the opposite is also possible. In any event, going forward, investors appear likely to differentiate more among euro area sovereign borrowers than they did prior to the financial crisis, to the disadvantage of euro area countries with higher-than-average debt burdens, like Italy.

FOCUS OF RATINGS REVIEW

Moody's review of Italy's sovereign rating will focus on the growth prospects for the Italian economy in coming years, and particularly the prospects for a removal of important structural bottlenecks that could hinder a stronger economic recovery in the medium term. The review will also examine the government's ability to achieve ambitious fiscal consolidation targets and to implement further plans to generate substantial primary surpluses in the medium term. This will include an analysis of the vulnerability of the Italian government debt trajectory to a rise in risk premia, as well as the options for the government to react. The government's new fiscal plan, which is expected to be announced shortly, will be considered during the review.

In addition, any broader developments across the euro area, in particular with regard to the resolution of the euro area debt crisis and its impact on funding costs, could be important determinants of the outcome of Moody's rating review.

PREVIOUS RATING ACTION AND METHODOLOGY

Moody's last rating action affecting Italy was implemented on 15 May 2002, when the rating agency upgraded Italy's Aa3 government bond ratings to Aa2 with a stable outlook. The rating action prior to that was taken on 3 July 1996, when the rating agency upgraded Italy's A1 government bond ratings to Aa3."

Source: Moodys.com

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